Why borrow? Rational Expectations Redux and why nominal prices matter

Unrealized capital gains were a particularly important factor in the increase in net worth over the 2004–07 period. The share of total assets attributable to unrealized capital gains from real estate, businesses, stocks, or mutual funds rose 5.1 percentage points, to 35.8 percent in 2007. Although the level of debt owed by families rose noticeably, debt as a percentage of assets was little changed. The largest percentage change in debt was in borrowing for residential real estate other than a primary residence.

With median and mean debt advancing faster than income, payments relative to income might be expected to increase substantially. In fact, total payments relative to total income barely increased, and the median of payments relative to income rose at a slower pace than it did between 2001 and 2004. Nonetheless, the share of families with high payments relative to their incomes increased notably.

From the 2007 Survey of Consumer Finances. Emphasis added.

Yet more evidence, together with the Permanent Income Hypothesis, that people look at their earnings power over time as an asset, just as any other asset, and their willingness to incur debt is due to how they price that earning-asset (together with their financial assets). A house is a 30 year commitment -- so you need to estimate 30 years of wages, discounted by both inflation and the risk of volatility in those wages. Same thing for other durables, and this percolates into day-to-day spending as well. "Flexible wages" are deeply destabilizing, as assets with volatile earnings are priced lower than assets with reliable earnings. Flexible wages would cause a further decrease in demand in excess of the actual change in wages.